149 Chapter 11 Equity dividends In this chapter, we take a closer look at dividends. We saw in chapter 10 that dividends play a central role in equity investment and valuation. Our focus there was value investing. Our concern here is rather different. We concentrate on the dividend stream itself, namely, the income that is received by long-run investors who hold the overall equity market, without any tilt toward or away from high-yielders. We begin in section 11.1 by examining the impact of dividend income on US and UK inves- tors’ long-run rates of return. We show that although year-to-year performance is driven by capital appreciation, long-term returns are influenced heavily by reinvested income. Given the importance of reinvested income, it is interesting to examine the time path of divi- dends in more detail. In section 11.2 we therefore construct dividend income indexes based on the sequence of annual cash dividends that have been reinvested back into the market. From these indexes, we estimate dividend growth rates for the United States and United Kingdom. These growth rates are not only interesting in their own right, but they also play an important role in valuation models, and can provide insights into the magnitude of the cost of capital. In section 11.3, we extend this analysis to all sixteen countries in our data- base, and compare dividend growth rates around the world and over time. Many analysts argue that long-run dividend growth should be related to, and ultimately bounded above, by growth in GDP. In section 11.4 we examine the relationship between dividend growth, GDP, and equity returns, and find some surprising results. Section 11.5 examines how and why dividend yields vary over time and across countries. We note that by end-2000, yields in the United States and worldwide were close to their 101-year low. We also observe that over the last two decades, US dividend growth has been low despite the excellent performance of the US equity market. Part of the explanation for the lower yields and dividend growth could be that companies have shifted away from paying dividends. In section 11.6 we examine the trends toward “disappearing dividends” and increasing stock repurchases. Section 11.7 summarizes this chapter. 11.1 The impact of income We have seen that equity markets around the world have generally performed well over the long run. But has the return been mostly attributable to price movements and capital gains or to dividends? Certainly, on a day-to-day basis, investors’ interest tends to focus mostly on price and market movements. Figure 11-1, which shows the annual capital gain and dividend components of US stock market returns over the 101-year period from 1900–2000, helps illustrate why this is so. The height of each bar represents the capital gain or loss during each year. The area plot shows the dividend income received over each year. Over a single year, equities are so volatile that most of an investor’s performance is attributable to share price appreciation or depreciation. Dividend income adds a relatively Brought to you by | The University of Texas at Austin Authenticated Download Date | 11/18/19 5:59 AM